FINANCIAL

LITERACY AND STOCK MARKET PARTICIPATION

SUMMARY

By

Ammi Julian Mwamunyi

1501213392

The finance industry has evolved with more financial products and services

being developed to meet the daily needs of various investors. The advancement

of financial markets has also altered structural reforms in social security.

Responsibilities for financial decisions are now changing from government and

employers towards private individuals. Thus, individuals are now more

responsible for their financial well - being.

But are individuals ready for this responsibility? Do they posses enough financial

literacy to execute their investment ideas positively? This is what this paper aims

to investigate.

The paper has designed an extensive list of questions aimed at measuring and

differentiating among different levels of financial literacy and financial

sophistication. They find that most people have basic financial knowledge, but

their knowledge doesnt get further when it comes to a little bit of sophisticated

financial questions. The paper also find that low literacy people are more likely

to rely on family and friends as their main source of financial advisors. Most

importantly, low literacy individuals are less likely to invest in stocks.

The paper has three main contributions:

1. They develop two indices of financial literacy and knowledge, which allow

them to differentiate among different levels of financial sophistication.

 2. They contribute to the methodology of measuring financial knowledge.

3. They provide a contribution towards the so-called stock-holding puzzle

i.e., the fact that many households do not hold stocks.

The findings they get have strong and important policy implications. First, it

shows financial literacy should not be taken for granted. Second, financial

literacy differs substantially depending on education, age and gender.

Data used for this research was from the 2005 De Nederlandsche Banks

Household Survey (DHS).

MEASUREMENT OF LITERACY

They designed two modules to measure and evaluate financial literacy. The

financial literacy questions are composed of two parts. The first set of questions

aims to assess basic financial literacy. These questions cover topics ranging from

the workings of interest rates and interest compounding to the effect of inflation,

discounting and nominal versus real values. The second set of questions aims to

measure more advanced financial knowledge and covers topics such as the

difference between stocks and bonds, the function of the stock market, the

working of risk diversification and the relationship between bond prices and

interest rates.

FINDINGS

Advanced literacy is low among the young, is highest among middle-aged

individuals (40-60 yrs.) and declines slightly at an advanced age. This means that

people may be learning as they age and perhaps, participate in financial markets.

The paper also tries to investigate whether financial literacy matters in financial

decision-making.
The paper finds that those with low literacy tend to ask financial advice from

family and friends. However this changes when moving to higher proportions of

financial literacy. Those with higher financial literacy tend to rely on books,

magazines, newspaper and financial information from the Internet. Also

household with high financial literacy tend to seek professional financial advice.

Also these individuals are less likely to use informal source of information such

as family and friends.

The paper also finds that stock market participation increases with age/cohorts;

stock ownership is concentrated among those 40 and older. The large proportion

of stock ownership for those older than 70 may simply be the result of

differential mortality between richer and poor households. Stock market

participation is lower among women compared to men. Also they find that stock

ownership increases sharply with literacy.

CONCLUSION

This paper shows that lack of understanding of economics and finance is a

significant deterrent to stock ownership. This prevents households from owning

stocks.